Serious lack of discussion in Canada about public-sector pension reform

Public-sector unions have negotiated pensions that lift their retired members far above the poverty line. Their plans have been heavily funded by Canadian taxpayers and provide a seamless level of income support for public-sector employees, spanning their careers and continuing into their retirement until death.

In fact, many retirees on public-sector plans have a higher disposable income in retirement than they had on average during their working years.

It is unfair for taxpayers to be on the hook for these liabilities.

There has been a serious lack of discussion in Canada about public-sector pension reform, but other governments have begun to address the issue. We suggest three ways to control the cost of public-sector employee benefits and at the same time make them fair for federal employees.

Equitable pension contributions between taxpayers and employees

Private-sector employers commonly match the retirement contributions of employees in Group RRSP savings plans. The federal government offers a very generous program whereby employees are required to fund only 35% of the cost of their retirement.

The C.D. Howe Institute estimates the federal public-sector pension plan to be underfunded by $200-billion. In 2010 total employee and taxpayers contributions into the federal employee pension plan were $4.3-billion, an increase of 15.5% over the previous year. Based on the current contribution levels (35%/65%), employees contributed $1.505-billion and taxpayers funded $2.795-billion in 2010.

If the contribution rates for public-sector employees and taxpayers were made equal (50/50) based on the current contribution rates this would have saved taxpayers $645-million based on last year's numbers. Assuming the yearly increase in contribution rate is the same in 2011 (to $4.95-billion) as it was in 2010 (15.5%), the potential savings for 2011 would have been $742.5 million.

C.D. Howe recommended a similar reform of federal employee pensions last year, but proposing a phase-in of payment equalization so the 50/50 ratio would be achieved over a period of years. Annual savings by 2016 would amount to $882million, with a total of about $2.3-billion over four years (See chart, below right).

Change the retirement age for the public sector

According to a 2008 StatsCan study, Federal Public Service Retirements: Trends in the New Millennium, Canada's public sector employees retire earlier than elsewhere in the world. The study notes that while the average age of retirement within the Canadian labour force in general is close to62, in the public sector 58 has been the average age of retirement over the past decade.

A major recommendation of the Independent Public Service Pensions Commission, known as the Hutton Report, from the U.K. was that the public sector and the general population should have a similar retirement age. Hutton concluded that the age at which public sector workers are entitled to draw their pensions be raised, as people are living longer. In Canada the CPP standard age for retirement is 65.

The Ontario Municipal Employees Retirement System estimates that the cost of early retirement is 16.14% of the total retirement pensions costs of a retired employee. The average new federal pension last year was $35,000 and the average Canadian who reaches age 65 now lives another 19.8 years, close to age 85.

A federal employee retiring with this average pension at age 55 will collect close to $1.4-million in lifetime pensions. The early retirement portion of this is estimated then at $227,000. Considering there are 317,088 federal employees enrolled in the pension plan, the cost savings would be $72-billion over the next 30 years. The savings for this program would be split 50/50 between taxpayers and employees.

Convert pensions from final average salary to career average

Current public-sector pensionsboost payouts by allowing members to use their highest three or five years' income as the base for pension benefit calculations. Private-sectordefined benefit pension plans use lifetime career average incomes.

An example: The Province of Saskatchewan closed its defined-benefit pension plan for teachers about 20 years ago, offering a defined-contribution plan. The Saskatchewan Teachers Federation refused the new plan, choosing to set up its own defined-benefit plan, using a final average salary base. Taxpayer and teacher contributions are now in this fund.

Faced with sole responsibility for the plan without any taxpayer guarantees of the benefits, they have had to make moves to ensure the long-term solvency. Their 20-year track record proved the plan is not sustainable, so they recently made the decision to move from a final-salary plan to a career-average plan. They will convert their plan to a career-average definedbenefit plan effective 2015.

With a salary grid reaching up to $75,210, our estimates show that the career-average pension is about 15% lower than the final-salary pension. This change should be implemented for all federal public-sector pensions. The final salary pension for a Saskatchewan teacher retiring today would be about $50,441 for a fully qualified pension. The career-average pension would be $43,350.

Once the retiree reaches age 65 in the Saskatchewan plan, the CPP kicks in and reduces the costs to the pension plan by $11,500. So the example above will cost the pension fund only $31,850 after age 65. With a life expectancy of 85, the teacher retiring at age 55 will earn $1.75million on the career-average pension compared to $2.04-million on the finalsalary pension, indexed at 2% per year, including CPP. This compares to a lifetime earnings while working of $1.9-million. This change will save $290,000 per retiree over the 30-year life of the pension plan.

The earlier taxpayer-guaranteed pension plan, which pays teachers in the system before the new plan, is currently $4-billion underfunded, and will be bankrupt by 2014. Shortfalls are common in pubic-sector pension funds, with the total federal pension deficit alone estimated at $200-billion.

The savings to move to a career-average in the federal pension plan is estimated at $290,000 over 30 years for each of the 317,088 active employees. On an annual basis this change would save $3.06-billion per year. Half of this savings would be in the pocket of taxpayers and the other half in the pocket of employees.

All told, these three reforms would save Canadian taxpayers some $3.5-billion per year while making the Canadian pension system sustainable.